How to Setup You Own Trading Business

Setting up a trading entity correctly is an important step if you are (or plan to be) a full-time trader. This will allow you to take advantage of many benefits that the typical investor does not have access to.

After reading this article you will have a grasp of:

How a trading business functions

What the components of a trading business are

What kind of expenses can you write off

It’s really quite simple,

Hobby’s cost money, businesses make money. The purpose of a trading business is to capture profits just like an ordinary business. The difference is you are not selling a product or providing a service, therefore the real benefits of creating an entity around your trading business is for tax purposes.

Forming Your Trading Entity

The most common way to setup a trading entity is as a Limited Liability Company (LLC) in the state which you live. While tax laws vary from state to state, they don’t provide a significant advantage when setting up your trading entity.

The name does not need to be extravagant, as the purpose of your LLC is to separate your trading capital from your personal investments, thus limiting your liability as the name states.

No matter what state you file your entity in, you will need to draft your Articles of Organization, a document which includes your:

Entity Name

Purpose

Known Place of Business Address

Members and Percent of Ownership

Member Signatures

In most cases you will be the sole managing member of your trading entity. I recommend reviewing the information at IRS.gov on setting up an LLC. It is also effective to file your LLC taxed as an S-Corp. This is strictly for tax purposes as it makes the itemization process easier.

Once you create your entity you can then file for an Employee Identification Number (EIN). This number will be used on all tax forms and trading accounts as this is how the IRS will identify your trading entity separate from your personal social security number.

Your licensed tax professional will be able to walk you through this process and answer any questions you have along the way. I would check to see if they have experience with trading tax accounting as there is a lot of grey area in the current laws.

Do You Qualify For Trader Tax status?

This is the first question you need to ask. I will reference Robert Green’s book, Tax Guide for Traders as this has become the industry standard for trader tax accounting.

There is no objective test to establish trader tax status qualification. The IRS developed the following criteria to determine if you’re eligible for trader tax status.

1. The taxpayer’s trading must be substantial, regular, frequent and continuous. Sporadic trading won’t be a trade or business.

2. The taxpayer seeks to catch the swings in the daily market movements and profit from these short-term changes rather than profiting from long-term holding of investments.

As you can see the criteria is quite ambiguous, however if you are day trading the futures markets for example and are a full-time trader and have no other major sources of income to pay your living you qualify without question. If you are a part-time trader because you have another business activity, the IRS may scrutinize your qualification for trader tax status.

What is Mark to Market Accounting?

Mark-to-market (MTM) refers to the procedure you follow at year-end when you mark all your open positions to market prices. MTM only applies to trading gains and losses it does not apply to a trader’s business expenses. You must elect MTM accounting; it does not default when you file trader tax status.

Commodities and futures use a different tax method than securities, the 60/40 rule. This means 60% is taxed at the long-term capital gains rate, and 40% at the short-term. MTM accounting is not a preferred method for profitable commodities and futures business traders because this blended 60/40 rate is significantly less than having your entire profits taxed at the short-term rate.

What if You Have a Losing Year?

Business taxpayers are allowed the benefit of net operating loss tax laws. These laws provide the opportunity to carry back and/or forward business losses. Make a fortune in one ear and pay your taxes then lose a fortune in the following years and carry back your net operating losses to get big refunds.

What Expenses Can a Trading Business Write Off?

Other benefits of setting up a trading entity are the ability to create retirement plans, deduct medical and health insurance premiums, and write off additional expenses such as computer equipment, travel to trade shows, and education materials.

Since your trading gains and losses are considered ordinary gains and losses when electing MTM accounting you may deduct in full against any type of tax return income. The ability to deduct home office and education expenses and depreciation on computers and office equipment is a benefit not allotted to the typical investor. The business trader may use schedule C for these business expenses.

Whether you decide to setup a trading entity and file for trader tax status or continue as a non-business trader, you must develop a detailed plan for the future if you want to succeed.

Consult Your Tax Professional

Make sure to consult with a licensed tax professional that is well versed in trader tax law. I have experience working with Traders Accounting. Since they only deal with trader taxes they are one of the best.

17 Responses to “How to Setup You Own Trading Business”

Do you know how taxes are treated for trading Binary Options? I’ve been trading Binary Options on Future’s contract indices like the S&P 500 or Russell 2000. Wasn’t sure if they fall under the 60/40 Futures rule, or if they fall under a more traditional option?

Hi Ben, this is a tough one. After a little digging it looks as though the 60/40 does NOT apply to binary options, however there really isn’t any tax procedures written into the current tax code. Trading taxes in general is a very gray area so my best recommendation would be to work with an accountant who has dealt with options trading in the past as this seems to be one of the more complicated aspects of trader tax filings. You might also reach out to your broker, they may have some more information in particular to binary options.

I have an accountant which reviews my taxes for me. I am not a licensed tax professional, but I speak from experience with my own taxes and from reading the book Tax Guide for Traders. There are a lot of benefits when trading Futures over such things as stocks and options in the United States, the most notable being the 60/40 tax treatment. This means that 60% of your profits are taxed at the long term rate (currently 15% in the US) and 40% are taxed at your specific income bracket level. This comes out to roughly 20-23%. Cost basis and recording of profit/loss is also much easier with futures. Robert Green’s book Tax Guide for Traders has become the industry standard as far as trader tax law goes these days. I highs recommend it.

Hi Tim, I just found your post about incorporating trading into business and started the process today and I am already lost, so I hope you would be able to help me. I am confused on which entity to choose, whether LLC, S-corp or C-corp. I was told that LLC if not a partnership will not receive EIN unless you have employees (or partners) and thus will be taxed as your income (passed down to your personal taxes), so not sure how it works taxing LLC as a S-corp. I am fine of having C-corp or S-corp though, but cannot make a decision which entity is the best. Can you advice or shoot your opinion?

If I have an LLC trading business do you pay self employment taxes as any other business. I’ve read where some say you don’t and some say you do pay this. I’m also interested in starting up an LLC, as I’m an individual investor right now. I believe I have some very good trading strategies that I can make a living doing this. I’ve broken my trading down to 1 being 1 day and buy/short in play stocks. 2 stocks small/cap holding for 2 -5 days. 3. mid/cap 2-5 days (if market is good to trade). 4. longer term hold 1 week to 6 months or more. this strategy has done very well for me. Basically that is it. I don’t believe in just one way I like to have multiple portfolios. All of these methods I’ve came up with them myself. Now I just want to see if I can do this full time and just worried about the taxes and wash sell rules. Since being an individual investor. Any suggestions would be helpful. Is there anyway that I can still keep my full time job and have daytrading llc in the irs’s eyes

Hi Chris, the tax law for traders is a gray area. I’m setup as an LLC taxed as an S-Corp. For day trading purposes it work well, if you were just swing trading on the side you could get away with filing those trades on your personal. Having the LLC is another tax return to file and pay for at tax time, but it does separate your trading from your personal and make it a little easier to manage. Even if you’re trading part-time, if you’re running it like a business then keeping things separate from your personal is the way to go.

Hello Tim, I know the article is old but I greatly enjoyed the insight given. I have been trading for some years & profitable the last 3 with a good mix of swing & day trading. I decide to trade through an LLC that I just setup later hoping to grow the business through traditional means like most traders. 3 questions, Are you paying unemployment Insurance for yourself being you consider yourself an employee of the S-Corp? Are you drawing a salary using a 3rd party payroll and deducting liabilities as a business expenses or just transferring money between trading acct & personal checking? lastly given the complexities of trading through a entity are you utilizing an acct software ie QuickBooks or does you CPA simply handle everything?

Hello Tim,
Just finished setting up my LLC S Corp. But have found the process of selecting a broker frustrating. As a LLC, I am considered a professional by the exchanges. Real time quotes can be extremely costly. How do you work within this constraint? In your opinion, who are the best brokers for this structure? Thanks!

Yep, I have Infinity and Thinkorswim accounts setup under the LLC. The benefits are you can separate your trading from your personal. I’ve been with both for more than 6 years so I’m not sure how the fee structures have changed.

You say, “MTM accounting is not a preferred method for profitable commodities and futures business traders because this blended 60/40 rate is significantly less than having your entire profits taxed at the short-term rate.”

Don’t you mean MTM accounting IS the preferred method? Why would you conclude that MTM is not the preferred method if (1) it’s mandated by IRS and (2) it results in lower taxes? Is this a typo? If not, please clarify where I went wrong. Thanks, great post and got me thinking about a subject that fell off the radar.

Another question. Most of my trading capital (90%) is in IRA’s. If I create an LLC, can I transfer those existing IRA’s into the LLC or do I have to start with brokerage accounts and fund IRA’s under the LLC using traditional IRS rules?

Great question Geoff. The reason is that for commodities and futures, the default tax rules allow for 60% long term and 40% short term capital gain, a bend of 23% (versus 35% for securities). Electing mark to market accounting converts commodities and futures trading capital gains and losses (this 60/40 treatment or 23%) to ordinary gain and loss treatment (the 35% tax rate, a 12% tax rate increase).

Hi Tim,
I know this is an old thread. But, in setting up my LLC I am faced with Pro exchange fees at my brokerage firm. Is this common or is there a way arround it?
I am pretty discouraged. Can I still benefit from the 60/40 rule if I keep trading as an individual?
Thanks for your insight. Greatly appreciate your guidance.

The tax rates are the same whether you are an individual or LLC. It’s only in the past few years that the brokerage firms have started charging extra if you’re registered as an entity. Luckily I was grandfathered in.